(Article from Insurance Law Alert, March 2016)
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The Wisconsin Supreme Court ruled that the incorporation of a defective ingredient into a nutritional supplement tablet is not “property damage” caused by an “occurrence” under Wisconsin or California law.
Wisconsin Pharmacal Co., LLC v. Nebraska Cultures of California, Inc., 2016 WL 785203 (Wis. Mar. 1, 2016).
Pharmacal supplied probiotic supplements to retailers. One such supplement was a tablet that was supposed to contain LRA, a probiotic bacterial species. However, after the tablets were shipped to retailers, it was discovered that the tablets contained LA, a different bacterial species. The tablets were recalled and the remaining inventory was destroyed. Pharmacal sued several of its suppliers and their insurers. The insurers moved for summary judgment, arguing that there was no coverage for the underlying claims. A Wisconsin trial court agreed and ruled that the insurers had no duty to defend. An intermediate appellate court reversed. The Wisconsin Supreme Court reversed the appellate ruling.
The Wisconsin Supreme Court ruled that under Wisconsin law, the question of whether the incorporation of a defective ingredient constitutes property damage turns on “whether the product is to be treated as a unified whole or whether a defective component can be separated out such that the claimed damage constitutes damage to property other than the defective component itself.” The court concluded that because all of the ingredients were permanently blended together in the manufacturing process, the tablet constituted an “integrated system.” The court therefore held that damage to the tablet was damage to the product itself and not damage to other property. The court also held that there was no “physical injury to tangible property” because there was no physical alteration of other ingredients, the container, or any other packaging component. Additionally, the court held that there was no “loss of use of tangible property” because the destruction of the products constituted a permanent economic loss rather than a temporary loss of use of property. Finally, the court ruled that there was no “occurrence” even though incorporation of the incorrect ingredient was accidental. Citing to faulty workmanship coverage precedent, the court reasoned that just as defective construction, standing alone, does not constitute an occurrence, use of a defective ingredient, in and of itself without resulting property damage, does not constitute an occurrence.
Applying California law to a second insurance policy that was at issue, the court concluded that the failure of a product to perform as intended does not constitute property damage. Although California courts have held that the incorporation of a hazardous component can constitute property damage, the court deemed such precedent inapplicable because the incorrect ingredient was not hazardous. The court further held that there was no “occurrence” under California law because the supply and incorporation of LA was deliberate, rather than accidental, even though the provision of the defective ingredient “may have been occasioned by negligence.”